UNCERTAINTY, PRICE STABILIZATION AND WELFARE

This paper investigates whether a small country facing foreign price instability benefits from active stabilization of the domestic price of the importable. If the random tariff revenue is rebated ex post, domestic price stabilization increases income instability, and nonintervention is optimal. If an ex ante rebating scheme is employed, a small country can benefit from domestic price stabilization, and there exists a partial stabilization policy that dominates free trade. Partial stabilization of the domestic price with the ex ante rebate requires a variable import levy inversely related to the foreign price.